Norway to Favor Gradual Rate Increases to Balance Krone, Demand

By Josiane Kremer

Oct. 28 (Bloomberg) -- Norges Bank, which today may become Europe’s first central bank to raise interest rates since the credit crisis started easing, will favor gradual increases as it seeks to balance krone gains against accelerating asset prices, economists said.

The Oslo-based bank will follow the Bank of Israel and Australia’s Reserve Bank to become the third central bank to reverse an easing cycle that brought Norway’s borrowing costs to a record-low 1.25 percent. Governor Svein Gjedrem will announce a quarter point increase in the overnight deposit rate at 2 p.m. today, a Bloomberg survey of 20 economists shows.

“It is a trade-off between the need for higher rates to curb the acceleration in home prices and the strength in private consumption” and “the effect of the krone exchange rate on the manufacturing sector,” said Bjoern Roger Wilhelmsen, a senior economist at First Securities ASA in Oslo and a former economist at the central bank. He expects borrowing costs to rise to a “neutral” rate of 5 percent to 5.5 percent within two years.

Norway, the world’s fifth-biggest oil exporter, suffered a milder recession than its Nordic neighbors, resuming growth in the second quarter as record-low borrowing costs and government stimulus measures equivalent to 4.7 percent of gross domestic product boosted consumer spending and kept unemployment the lowest in Europe. Prime Minister Jens Stoltenberg, who was re- elected last month, has pledged to continue spending in excess of national fiscal guidelines for a second consecutive year.

‘Extremely Low’

Gjedrem said on Sept. 30 that asset prices “have risen sharply and probably excessively,” characterizing policy rates as “extremely low.” Five days earlier, Gjedrem gave a speech saying that a strengthening of the krone “suggests that the key policy rate should be kept low for a period ahead.”

The krone has gained 7.8 percent against the euro since the end of June, making it the second-best performer of the 16 major currencies tracked by Bloomberg in the period. A further strengthening would hurt exporters including Norsk Hydro ASA, Europe’s third-largest aluminum producer, and Norske Skogindustrier ASA, the world’s second-biggest newsprint maker.

“In my view we will see a cautious start of the hiking cycle,” Wilhelmsen said.

At the same time, house prices in the only Scandinavian country that isn’t a member of the European Union have returned to a peak reached in the summer of 2007, not taking inflation into account, according to the Finance Ministry.

Housing Peak

House prices rose a quarterly 1.8 percent in the three months ended September, after gaining 5.3 percent in the previous quarter, Statistics Norway said on Oct. 14.

House prices grew even when the economy was in a technical recession as unemployment, which fell to 2.7 percent in September, remained the lowest in Europe throughout the credit crisis. Norwegians, the world’s second-richest citizens per capita after Luxembourgers, didn’t have to wait long for low interest rates to feed through to disposable income, with about 90 percent of mortgage holders using floating rates, according to the Finance Ministry.

“We see a very big difference between strong growth in private consumption and household demand and a quite strong contribution from the public sector,” Wilhelmsen said. “On the other hand, the construction sector is still suffering and the export sector is quite weak.”

Oil Wealth

The country’s oil wealth has shielded it from the worst of the economic crisis, and mainland GDP, which excludes oil, gas and shipping, grew 0.3 percent in the second quarter, ending six months of recession. The government expects the economy to grow 2.1 percent next year after contracting 1.1 percent this year. The jobless rate will average 3.2 percent this year and 3.7 percent in 2010.

The strong growth outlook has helped the krone outperform Sweden’s krona against the euro since the end of March.

“We think the currency will limit the room for the central bank to hike interest rates going forward,” said Maren Romstad, currency strategist at DnB NOR ASA, Norway’s biggest bank. “The export sector is still struggling and a stronger krone will only weaken the sector further.”

The krone will continue to strengthen as the global economy recovers, said Erik Bruce, senior economist at Nordea Bank AB in Oslo. “The strengthening of the krone means that core inflation will maybe go down to 1 percent next year and it means that the export sector will have problems on the international market.”

Inflation

The central bank targets price growth, adjusting for the effect of energy and taxes, of 2.5 percent. Inflation accelerated to 2.4 percent last month from 2.3 percent in August. Inflation has exceeded the bank’s target in six of nine months this year.

Exports will recover more slowly than consumer demand, the government forecasts, rising 0.1 percent in 2010 after slumping 6.5 percent this year.

Bruce expects Norges Bank to move “gradually” and increase rates at every second meeting to 2.75 percent within 12 months. If the bank “moves too fast, we will surely see an even stronger krone and that will lead to a too tight monetary situation, too low inflation.”

Norges Bank also releases its revised economic forecasts and rate path today.

To contact the reporter on this story: Josiane Kremer in Oslo at Jkremer4@bloomberg.net.